Alchemy of Financial Innovation: Securitization, Liquidity and Optimal Monetary Policy

61 Pages Posted: 20 Feb 2019

See all articles by Jungu Yang

Jungu Yang

Bank of Korea - Economic Research Institute

Date Written: February 20, 2019

Abstract

This paper provides a theoretical model to explain how securitization affects the overall liquidity and welfare of an economy, an under-discussed area in the literature. By applying an overlapping generations model with random-relocation shocks, the effects of securitization are analyzed in three different hypothetical situations:

1. only one region of the economy issues securities,

2. all regions issue securities with the same capital productivity, and

3. all regions issue securities, but capital productivity is disparate across regions.

Asset securitization plays a role in supplying alternative liquid assets (fiat money). As the economy can invest its resources more efficiently in high-yielding illiquid assets (capital) due to securitization, both consumption and welfare increase overall. Optimal monetary policy follows the Friedman rule in cases 1. and 2. However, the rule does not apply in case 3.

Keywords: Securitization, Liquidity, Friedman Rule, Monetary Policy

JEL Classification: E52, G11, G12

Suggested Citation

Yang, Jungu, Alchemy of Financial Innovation: Securitization, Liquidity and Optimal Monetary Policy (February 20, 2019). Bank of Korea WP 2019-10. Available at SSRN: https://ssrn.com/abstract=3338172 or http://dx.doi.org/10.2139/ssrn.3338172

Jungu Yang (Contact Author)

Bank of Korea - Economic Research Institute ( email )

110, 3-Ga, Namdaemunno, Jung-Gu
Seoul 100-794
Korea, Republic of (South Korea)

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